I have two decades of experience trading currencies and fixed income instruments. My market analysis skills were honed during my tenure as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006 as Chief Currency Analyst, I have been publishing a daily commentary on global markets. I lead a team with 24/7 North America, Asia and Europe forex market coverage. Born in Dublin, Ireland, I hold a degree in Economics and Finance from Trinity College Dublin.

EURO Continues To Punch Above Its Weight Class

Has the month-end distorting of prices already begun? The single currency has managed to slice through that psychological 1.35 barrier like a ‘hot knife through butter’ just as other asset classes stood still. There has been no helping hand from equities, commodities, or fixed income. Technical demand from EUR/JPY and EUR/GBP has managed to lift the 17-member cultured currency to take out the 1.3525 barrier. True to form, the EUR has maintained its momentum this week after the European Central Bank (ECB) has been willing to maintain its favorable outlook. Also today, the market gets to question the U.S. Federal Reserve’s outlook.

A technical driven move for the EUR, overnight fundamentals would prefer to hinder rather than help the currency. A disappointing preliminary Spanish reading of gross domestic product (GDP) for Q4 should have been capable of stalling this EUR rally.

Spanish Economy Sinking Spanish GDP fell -0.7% from the previous quarter and -1.8% from the same period last year. This headline print was slightly worse than the reading from the Spanish Central Bank last week. It appears analysts believe that the Q4 result will be the worst of it for Spain, despite predicting further economic contraction throughout 2013. A recent development in leading indicators is being used to support this prediction.

So how much trouble is Spain really in? Earlier this week we saw reports confirming the Spanish unemployment at +26%and abysmal December retail sales figures in-line with the recent trend hindered by higher value-added tax rates implemented last September. Now one of the autonomous communities of Spain– Catalonia — is asking for another handout.

The Spanish region has requested +EUR9b from the country’s liquidity fund. Last August they received +EUR5b. It seems the symptoms are becoming more pronounced for the European Union’s fourth largest economy. Periphery spreads are telling us not to be worried – at least not yet.

Eurozone consumers and businesses became less pessimistic about their prospects this month, but they still do not feel confident enough to increase spending to get them out of this dire economic cycle. This is the crux of the problem. Central banks have been relying heavily on the consumer to spend their way out of the crisis, and three years later we are still talking about it.

Improved sentiment data “echoes a shift in mood among investors”. But the ‘proof is in the pudding’, the EUR is higher as too are equities and bond prices. The European Commission’s Economic Sentiment Indicator rose to 89.2 from 87.8 last month. It was the third consecutive rise and currently sits at its highest level in 12 months. If sustainable, the revival in business confidence should logically lead to a rise in investments and new hiring. However, it remains a phenomenon yet to be seen.

Enter The Fed The main event today stateside will be the Federal Open Meeting Committee (FOMC) meeting results, which should be somewhat less eventful than last month.

FOMC statement and rate announcement is at 2:15PM EST

Market consensus has the Fed’s policy taking no action whatsoever.

The December minutes released at the beginning of January indicated that some Fed officials saw QE3 concluding “well before the end of this year.” At the time, this allowed the market to speed up the pricing of winding down QE3 and the timing of U.S.’s first-rate hike. The market now seems to agree that the pricing has been overdone. The market will be looking forward to the January minutes released in three weeks for clarity.

The most anyone expects to come out of this meeting is perhaps further clarification, if any, of its intentions moving forward of purchases and/or selling of assets from its balance sheet.

The main difference and the predominant reason for the current EUR bid market is the perception that the ECB is actually paying down debt on its balance sheet. The market is now taking its cue from the ECB’s newly scheduled Long-term Refinancing Option (LTRO) announcements each Friday (European banks’ three-year loan payback releases).

The FOMC debate, if any, will focus on potential losses that may be suffered by the Fed from asset and debt pricing (falling bond prices and rising interest rates). This market should not be hung up on re-pricing. It’s basically an investor perception argument.

Remember, the Fed has the printing press and will print enough monies to cover losses. Alternatively they can hold the securities to maturity, thus erasing the loss. As it’s a perception issue for investors, they are incorrectly focusing on profit and loss columns.

The Fed is to push on with purchases of $40b of Mortgage Backed Securities and $45b a month of Treasuries despite some market criticism that it will eventually be in a tight spot. A balance sheet expansion will eventually impair efforts to tighten policy when necessary.

Ahead of the FOMC, we’ll get a taste of U.S. Q4 GDP data. The market anticipates a slowdown to +1.1% annualized rate. Expect some temporary factors to explain away some of this fall. One cannot argue with Hurricane Sandy, hopefully a once-in-a-lifetime anomaly, and perhaps other fundamental factors such as a wider trade gap.

How negatively will this market react to a similar headline? Let’s hope investors take into account this month’s showing as possible signs of reaccelerating before they decide to sell ‘the house’.

Another reason for the current support of the EUR this morning is that the ECB allotted only +EUR3.71b to Eurozone banks at its three-month re-financing operations. The volume is less than the +EUR6b that is maturing tomorrow.

The lower-than-expected bid is partial proof that the banks that indicated last Friday that they would pay back the +EUR137.16b on the three-year loans two years early are genuine.

Event risk now moves to the U.S.’s GDP and FOMC.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

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